Abandon the Couch Potato? Never!

Oct 19, 2000

Article By: Scott Burns

Q. Why have you given up on the couch potato approach after only ONE year of performance below that of other methods?

You are becoming a closet trader. The whole idea is to stick with the plan over the long haul, as you have preached before. Perhaps Bogle is correct, that one should be into the total market index for the long haul. How about comparing 50-50 and 75-25 couch potato with total market 50-50 and 75-25 over the long haul historically?

Have you become a sector trader and lost the faith??

--- T.F., by e-mail

A. Lots of readers have asked the same question since my September 24th column looking at shifts in the marketplace and suggesting possible alternatives to the basic Couch Potato Portfolio.

In fact, I haven't given up on simple, low-cost investing. The principles behind the Couch Potato Portfolio remain the same. But the tools we can use have changed since I introduced the first Couch Potato Portfolio in 1991.

When I researched the Couch Potato portfolio I did not use mutual fund data. I used indexes from Ibbotson Associates annual book, "Stocks, Bonds, Bills, and Inflation"--- core reading for students of investing. I used those indexes because they had longest histories.

The research showed that a simple portfolio invested 50/50 in a major index like the S&P 500 and in intermediate maturity government bonds would do two things. First, it would roughly reproduce our collective financial asset ownership, guaranteeing that your assets would rise in synch with the rest of the country. Second, this simple portfolio would do better than most managed funds over a long period of time, with less risk.

The hard part was finding the tools for making the actual investments.

At the end of 1991 there were only 35 index funds in operation (compared to 310 today). Of those, only 7 had been in operation for at least 5 years and, of those, 3 required minimum investments of $100,000 to $5 million.

There were only 4 index mutual funds for the retail investor in 1991.

You could choose the Wells Fargo Equity Index fund or the Vanguard 500 Index fund to reproduce the performance of the Standard and Poors 500 Index. You could choose the Vanguard Small Company Index, based on the Russell 2000 index, for small companies. And you could invest in the Vanguard Total Bond Market Index for fixed income.

There were no other choices.

Vanguards' Extended Market Index fund, which mimics the performance of the Wilshire 4500 index and invests in everything that is NOT in the S&P 500 index, wasn't available until December 1987. Vanguards' Total Stock Market Index wasn't available until April of 1992.

The original Couch Potato Portfolio was 50/50 Vanguard Index 500 and Vanguard Total Bond Market because those were the best tools available at the time.

Since then two things have happened. First, most people now have more than 50 percent of their financial assets in equities. The typical 401k account, for example, is about 70 percent equities. Second, the long bull market has brought on a flood of new stock offerings with enthusiastic valuations. As a result, the Standard and Poor's 500 Index has gone from accounting for 85 percent of all market value in America to accounting for 'only' 76 percent of all market value in America.

I started to report on the performance of the "Aggressive, 75/25, Couch Potato Portfolio" to account for the first change.

When the S&P 500 Index accounted for 85 percent of all domestic market value it was easy to say it was a good proxy for "the market", particularly since there were no alternatives. Today, with the same index missing 24 percent of all market value and the Vanguard Total Market Index fund in operation since 1992, we've got a better tool and a greater need to cover the entire market.

How big a difference will a switch to the Total Market fund make?

Enough to make you notice in the current market, less over long time periods. In the first 9 months of this year, for instance, the Vanguard Index 500 fund lost 1.40 percent while the Vanguard Total Market fund lost 0.40 percent, a 1.0 percent difference. Since then, stocks have continued to sink.

The table below shows the differences in performance for two Couch Potato Portfolios in each year since 1993, the original Index 500 Couch Potato and the Total Market Alternative. In both cases the fixed income index fund is the Total Bond Market Index Fund. It would also be possible to replace an S&P 500 index fund with one of the new exchange traded funds such as the iShares Russell 1000 Index Fund (ticker IWB) or the iShares Russell 3000 Index Fund (ticker IWV), covering the largest 1,000 and 3,000 domestic stocks, respectively.

This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational puposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown.

AssetBuilder Inc. is an investment advisor registered with the Securities and Exchange Commission. Consider the investment objectives, risks, and expenses carefully before investing.